I have had a commentator point out a somewhat ridiculous error in the blog. I intended to write about the recent G20 communique, and instead pulled up the text from the previous communique. Thank you to Tiberius who (very politely pointed out this error).
Essentially, the error was caused by a search for the document pulling up the older version. I should have checked the dates. This is a serious error and I therefore would like to offer my apologies. My aim was to go straight to the source, rather than rely on the interpretation of others. However, checking that I have the right source is a good starting point.
I have left the post as it stands. The principle of this blog is that nothing is deleted - even if it is rather a bad mistake. I only ever add notes and comments (as in this example) and date the change. However, in light of the error, please disregard this post. Once again, please accept my apologies for an idiotic and careless mistake.
I was puzzled at some of the commentary in the other media, but their commentary makes rather more sense now.....
Original post follows:
As promised a post on the G20 outcome. If you have the time you may wish to read the full text of the official communique, which can be found here.
Perhaps the most striking thing about the communique is the acceptance that the nature of the financial system was such that the world developed an unsustainable imbalance. However, the way that this is phrased still fails to accurately reflect that many of the imbalances were the direct result of policies of central banks, and no mention is made of the role of the regulators in creating the financial products that were to play such a large part in the crisis. In fact, the communique offers a vague and disingenuous picture of the causes. As such I will quote the section titled 'Root Causes of the Current Crisis' and examine it in some depth:
3. During a period of strong global growth, growing capital flows, and prolonged stability earlier this decade, market participants sought higher yields without an adequate appreciation of the risks and failed to exercise proper due diligence. At the same time, weak underwriting standards, unsound risk management practices, increasingly complex and opaque financial products, and consequent excessive leverage combined to create vulnerabilities in the system. Policy-makers, regulators and supervisors, in some advanced countries, did not adequately appreciate and address the risks building up in financial markets, keep pace with financial innovation, or take into account the systemic ramifications of domestic regulatory actions.The best way to examine this, is to take each point, and examine how it reflects the reality. Point (1) is as follows:
4. Major underlying factors to the current situation were, among others, inconsistent and insufficiently coordinated macroeconomic policies, inadequate structural reforms, which led to unsustainable global macroeconomic outcomes. These developments, together, contributed to excesses and ultimately resulted in severe market disruption.
'During a period of strong global growth, growing capital flows, and prolonged stability earlier this decade, market participants sought higher yields without an adequate appreciation of the risks and failed to exercise proper due diligence.'They describe economic growth during recent times, and this is an accurate description of the world situation. However, what they do not acknowledge is that the so called growth of the Western economies was a growth in activity form debt expansion, not a growth in wealth. In other words the growth was centred in the developing economies, and the growth in the Western economies was illusory (a post which shows how illusory that growth is can be found here).
With regards to the market participants (the major banks) seeking higher yields and taking risk, they were simply responding to two factors. One of these was the wall of money flowing into Western economies due to factors such as the low interest rates and Quantitative Easing (printing money) in Japan, the massive accumulation of petro-money in the Gulf states, and the quasi-mercantilist policies of China to achieve export growth. The problem such a wall of money might create is that, whilst the first tranches of money might be usefully used, the later tranches of money would have ever less opportunity to be invested in productive investments. The money had to go somewhere, and we can see the roots of bad lending into consumer markets. These imbalances were not the result of 'markets' but the active manipulation of the economy by governments.
If we combine this with the Basel regulatory framework (the other factor) it is possible to see the severe problems which can be firmly laid at the door of the central banks, and regulatory systems. Even the Bank of England admits that Basel I was the spur towards securitisation, and encouraged off-balance sheet activity. To this we might add that the system was responsible for the use of ratings agencies to assess products (e.g. CDOs), and the internal 'rocket scientist' calculation of risks that proved to be so wrong headed. Finally, the accords actively encouraged banks to lend to governments for the purposes of capital adequacy, thereby offering a further spur (as if any were needed) for some Western governments to borrow excessively (thereby leaving them vulnerable to the current shocks). A longer discussion of how the regulatory system helped to cause the crisis can be found here (a long post, and this is just one element of it).
In other words, whilst the banks may reasonably be cited as problematic, if not idiotic, they were in large part responding to a regulatory and macro-economic environment that was determined by government and central banks. It is always difficult to assign culpability in such cases, but there is much that can be laid at the doors of those who are behind the communique, those who now profess wisdom after the event.
Point (2) is as follows:
At the same time, weak underwriting standards, unsound risk management practices, increasingly complex and opaque financial products, and consequent excessive leverage combined to create vulnerabilities in the system. Policy-makers, regulators and supervisors, in some advanced countries, did not adequately appreciate and address the risks building up in financial markets, keep pace with financial innovation, or take into account the systemic ramifications of domestic regulatory actions.Whilst this appears as an acknowledgement of fault by regulators and government, it still essentially pins the blame firmly on the banks. The nearest it comes to any real acknowledgement is the mention of 'ramifications of domestic regulatory actions', but this fails to accept that the underlying problem was resultant from the combination of factors outlined in response to point (1). By appearing to accept a modicum of fault, this is simply a distraction from the depth of the problems that were created by those controlling the economic system.
Point (3) is as follows:
Major underlying factors to the current situation were, among others, inconsistent and insufficiently coordinated macroeconomic policies, inadequate structural reforms, which led to unsustainable global macroeconomic outcomes. These developments, together, contributed to excesses and ultimately resulted in severe market disruption.This ignores the single most important factor in this economic crisis, a point that I have discussed at many points in this blog. The real underlying cause of the crisis is the doubling of the global labour force in a period of about 10 years, resultant from the increases in mobility of capital, access to technology and access to world markets (discussed in more detail here). It is simply baffling that one of the most dramatic changes in the world economy continues to be ignored -even as a potential factor.
Having misread the causes of the crisis, it is inevitable that the solutions that are proposed are going to be misdirected. On the positive side, at least the communique acknowledges the severity of the problems, but it would be impossible to do otherwise. I will go through some of the points that they are proposing:
Continue our vigorous efforts and take whatever further actions are necessary to stabilize the financial system.This raises the simple question of what has been achieved so far? $US trillions have been poured into various bailouts, and yet there is still a dysfunctional financial system. Banks which are completely insolvent continue to absorb ever more money whilst still remaining insolvent. The latest method of hiding the insolvency is the change in the 'Mark to Market' valuation of assets, which is a way of hiding the underlying (non) value of assets. Quite simply, such policy is delusional. The latest Geithner plan for the US financial system, is just yet another case of destruction of wealth dressed up as salvation. However it might be spun, an artificial price will be set for toxic assets, and the inevitable losses will have to be 'monetised'. Such monetisation means yet more printing of money such that, one way or another, every $US will be taxed to pay to support insolvent financial institutions.
At each stage of the bailouts, there are the same promises that the latest measure will solve the problem, but each time the bailout fails another round of bailouts follow. All the time, there is talk of 'getting credit flowing again', as if the trade imbalances might be solved by endless expansion of credit.
Underlying all of this is a belief that some financial institutions are simply 'too big to fail', and this is at the heart of the problem. Governments have determined that these financial firms can never fail, and then wonder why they take outrageous risks. They have created a casino in which, if you bet on black and red comes in, it becomes an inconvenient blip in your operations. One way or another, it will eventually be back to business as usual, with every other sector of the economy paying for bank losses.
The next point is as follows:
Recognize the importance of monetary policy support, as deemed appropriate to domestic conditions.This should win prizes for having no meaning whatsoever. What on earth might this actually mean? Does this mean that, in the past, this has not been policy? Have governments and central banks previously not recognised the importance of monetary policy support?
The point that follows this does, at least, offer something that might have a vague meaning:
Use fiscal measures to stimulate domestic demand to rapid effect, as appropriate, while maintaining a policy framework conducive to fiscal sustainability.The key word in this is sustainability, but what might or might not be sustainable is not mentioned. For example I have, since the start of this blog, suggested that the UK government would need to turn to the IMF for funding for the very reason that the fiscal policy would not be able to be sustained in the face of economic crisis. From the Telegraph we have an article in which 'a senior cabinet minister' is talking about the necessity to go the IMF. The latest spin on this is to say that it is no longer to be seen as an act of desperation, which is perhaps one of the most audacious incidents of spin in this whole crisis. Can the US fiscal policy be sustained? The Congressional Budget Office thinks not....
I also asked in the early posts in this blog who might be able to fund the IMF as the crisis deepens. As if on cue, there is now the news that the IMF is simply going to print money to pay for activities:
Is the endless fiscal expansion based upon credit, endless expansion of the money supply sustainable? What do these people think money actually is? Is it some magic thing that can create actual wealth from nothing? Does the production of money of itself make us wealthy, or does our labour make us wealthy? Endless borrowing for consumption and spending and printing of money does not create wealth - it simply destroys it.
At the behest of the world leaders, the IMF will increase the amount each country has in so-called Special Drawing Rights (SDR) by $250bn.
This is effectively global quantitative easing – comparable to the unprecedented measures the Bank of England carried out last month when it committed to pumping £75bn into the British economy. This is a form of printing money.
Under the IMF scheme, each country has an allocation of a shadow IMF currency – known as SDRs. This currency can be converted into useable currencies such as dollars, euros or sterling. The amount of SDRs was dramatically increased by more than ten-fold yesterday. The scheme is best regarded as a safety valve for struggling economies, and rich countries are likely to donate some of their SDR allocation to those most in need.
As this is already a long post, I will not go into more detail on this, although this deserves greater consideration. Instead I will jump to the discussion of regulation. On the one hand the communique insists that regulation is a national concern, but on the other suggests that action should be taken to avoid 'regulatory arbitrage' i.e. seeking out the best regulatory environment. That these two goals are incompatible is surely obvious? They later say:
We call upon our national and regional regulators to formulate their regulations and other measures in a consistent manner. Regulators should enhance their coordination and cooperation across all segments of financial markets, including with respect to cross-border capital flows. Regulators and other relevant authorities as a matter of priority should strengthen cooperation on crisis prevention, management, and resolution.So what they really mean is that there will be international standards. However, assuming that they can come up with a commonality of regulation, is that a good thing? The first point to mention is that the Basel frameworks had this goal, but were in fact major contributors to the crisis. There are many more passages that have similar objectives. Perhaps the absurdity of such regulatory aims can be found in these passage from the communique:
Strengthening Transparency and Accountability: We will strengthen financial market transparency, including by enhancing required disclosure on complex financial products and ensuring complete and accurate disclosure by firms of their financial conditions. Incentives should be aligned to avoid excessive risk-taking.And:
Enhancing Sound Regulation: We pledge to strengthen our regulatory regimes, prudential oversight, and risk management, and ensure that all financial markets, products and participants are regulated or subject to oversight, as appropriate to their circumstances.At the heart of this is the central delusion that risk can be managed and assessed. It is the idea that risk is somehow something that can be defined. This is exactly what the Basel regulatory framework sought to do. This is the Basel framework that said that essentially said that OECD banks were 'safe'. They were not. Why will the next method of assessing risk be any safer? The same people who made this error are likely to be the same people who will make the next determination of risk.
Even more disturbing is the detail. For example we have the following:
Mitigating against pro-cyclicality in regulatory policyWe can all remember talk of the 'Great Moderation', the 'New Economy', the 'post-Industrial Economy', or the infamous Gordon Brown statement of no more boom and bust. Just as the determination of what was safe was completely wrong, so was the determination of the state of the world economy and national economies. Once again, the same people who called the world economy wrong, who called the state of national economies wrongly, will be the ones that will now apparently call them right. Why should such assertions be taken seriously?
In one respect, the communique does offer a positive perspective, and this is the commitment to open trade. However, there are no mentions of what allowed the severity of the distortions of trade, such as central bank manipulations of money supply. Whilst tariff barriers are important, they pale into insignificance compared with the potential distortions in the money supply, such as those created in Japan, or the Western economies. What of Chinese mercantilism - holding down their currency to ensure export growth, and to make imports more expensive? Can a system of open trade work in a system where these distortions are allowed?
Inevitably, the communique covers a lot more detail, and I will not comment on each and every point. A summary of the communique can be seen as follows:
- An assessment of the crisis that ignores the centrality of governments and central banks in the creation of distortions - and crucially ignoring the effects of the impact of the massive input of labour and the role of this expansion in the crisis
- A belief that the same people who failed to see this crisis coming will see the next crisis coming
- A belief that the same regulators who set up the current system, with terrible results, will be able to regulate against another crisis
- A belief that risk can be seen in advance, even though history shows us that it can not be foreseen
- A belief that a more unified regulatory system will stop crises, when the previous attempt to do so helped create the systemic nature of the current crisis
- No mention of how the money supply in individual economies is one of the most central/important factor in the world trading system - just some vague illusions with no action on this central factor
In the case of the Western debtor economies, if our 'betters' were to accept their role in the crisis, they would need to forgo some of their power. In particular, they would have to abandon the fiscal irresponsibility that allows them to spend the future wealth of their voters, whilst pretending that it is the government's money to spend. It would mean that they would have to abandon their endless expansion of money and credit, and face up to the underlying real wealth creation of their economies, and face the fact that their policies of borrow and spend simply can not be continued. It is a message they fear telling the voters, and so they pretend that such a system might continue.
For the creditor nations, they would need to face the fact that they have been pouring their wealth into a delusion, and that they must accept that the paper they exchanged for their wealth is of little value. That would be a very bitter pill for them to swallow.
The G20 is a whitewash, which just promises more of the same delusion that put the world economy into this mess in the first place. It is the same people with the same delusions offering more delusions. It is not a new world order, but the maintenance of a fantasy old world order. Quite simply, they propose more and more of the economic tinkering that hid the changes that took place in the world economy - the massive expansion of the world labour force. Their solution is to try to maintain the imbalances that this expansion created. Rather than accept the real redistribution of wealth that this represents, they are seeking to pretend that they can keep going on as before - just with ever more of the kind of 'control' that turned an adjustment into a crisis.